Within the tax law practice of the civil law firm Costaș, Negru & Asociații, a VAT case that was resolved favorably during the appeal resolution phase caught our attention. We comment on it here, as we believe that the legal issue under consideration is one of general interest.
I. Introduction
The deductibility of VAT is a thorny problem for the tax authorities, since the right to deduct VAT is often denied to the taxpayer because the tax authority considers the expenses incurred as not having been incurred for taxable purposes. This problem is all the more prevalent among economic operators active in the construction sector, given that a number of taxable operations are carried out before the actual construction takes place.
It is therefore of interest to analyze the deductibility of taxable operations related to the construction sector, assuming that the purpose for which they were carried out has not yet materialized. The analysis carried out is based on a recent Decision of the Settlement Body of the Ministry of Finance, the General Directorate for the Settlement of Complaints, where the Civil Law Firm Costaș, Negru and Associates provided legal representation to an economic operator active in the real estate construction sector, in relation to a real estate project in progress.
II. Factual context
In order to realize a real estate project, in partnership with the local public administration, the economic operator advanced multiple expenses such as geotechnical studies, preparation of technical documentation, design services and design design, as well as advance payments for certain works on which it has justifiably decided to exercise its right to deduct VAT. It is important to note that the company was not realizing any income at the time of the tax inspection, as this real estate project was at the stage of authorization, which will only later allow the construction works to be carried out, in order to be able to start the economic activity by selling the housing units to be realized on the basis of the real estate project. The company argued that the VAT liability is not deferred because of the absence of building permits or because the construction works have not started. The delay in these stages was also due to the fact that the local public administration imposed additional obligations on the company and to the requirements imposed by the local public administration to ensure that the project complied with local urban planning rules.
However, the tax authorities have imputed to the company that the deductibility of these expenses could not be recognized in the context that there was neither an approved zoning plan nor a valid building permit issued. Therefore, it was considered that economic operators cannot invoke certain future operations whose existence is uncertain in order to prematurely claim the deductibility of expenditure incurred for those purposes. As a consequence, the findings of the tax inspection team were to the effect of not recognizing the right of deduction of the economic operator, thus establishing additional tax liabilities consisting of VAT deducted for expenses incurred in the phase prior to the authorization and execution of the real estate project.
III. Ruling offered by the resolution body
Analyzing the merits of the contested administrative act, the Directorate General for the Settlement of Appeals ruled that it should be annulled because the decision of the tax authority to refuse the taxpayer’s right to deduct cannot be considered legal and well-founded on the grounds that the taxpayer does not carry out an economic activity (thus not registering any income), and the real estate project for the purpose of which the expenses were advanced was not subject to the authorization procedure by the local public administration. Therefore, the resolution authority considered that the expenses started in the early stages of this project were incurred for taxable purposes, even though per se the expenses do not consist in the commencement or continuation of construction works, as envisaged by the company’s real estate project.
IV. Implications concerning the recognition and exercise of the right of deduction of economic operators active in the real estate construction sector, in the light of the case law of the CJEU
Recognizing the economic operator’s right of deduction in this particular situation is simply a reaffirmation of the principles formulated in the case law of the European Court of Justice on the right to deduct VAT.
From a theoretical point of view, the right of deduction is the right recognized to taxable persons liable to VAT who are the recipients of supplies of goods or services to a refund of the tax on those supplies. This right of deduction is activated when the tax becomes chargeable and belongs to each taxable person in respect of goods or services which have been supplied to him or which are to be supplied to him or which are to be supplied in the future. Essentially, the right of deduction is intended to apply the principle of fiscal neutrality, which seeks to eliminate the burden of VAT due or paid by the economic operator in respect of his activities for as long as they have been carried out for taxable purposes, irrespective of the purpose of those activities.
However, the exercise of the right of deduction is circumscribed by the provisions of Article 299 of the Tax Code, which makes the exercise of this right conditional on the fulfillment of two elements, namely those of form (the possession of a correctly drawn up tax invoice) and substance (the operations for which the right of deduction has been exercised must be carried out for taxable purposes, for the conduct of the agent’s economic activity). However, we must not lose sight of an important aspect, namely that, for the exercise of the right of deduction, the fulfillment of the conditions of substance prevails over the conditions of form. This conclusion follows from a rich case-law of the Court of Justice, such as in Nidera Handelscompagnie, C-385/09 and Kopalnia Odkrywkowa Polski Trawertyn P. Granatowicz, M. Wąsiewicz, C-280/10, where the Court held that the principle of fiscal neutrality requires that the right to deduct VAT must be granted to taxable persons where the transactions in respect of which that right of deduction has been exercised were carried out for taxable purposes, even if certain formal conditions are not met in the case at hand.
Referring to the specific field of construction, the right to deduct VAT has been recognized as existing from the very moment of acquisition of the land intended for the construction of the real estate project, in view of the considerations of the ECJ expressed in Gran Via Moinești SRL, C-257/11. The aforementioned case also concerned the refusal of the tax authorities to recognize the individual’s right of deduction for the purchase of certain land to be used in the future for the construction of residential buildings. In this case, the tax authorities refused to exercise the right to deduct VAT because it was considered that the purchase was in fact made for the demolition of existing buildings on the land and not for the construction of a future housing complex. The ECJ reiterated its own case law in which it pointed out to the litigants that the notion of ‘economic activity’ contained in Art. 9 para. (1) of VAT Directive 2006/112/EC encompasses several consecutive acts of the same operation, such as preliminary acts such as those in the present case, namely the purchase of land. Accordingly, even if, in the present case, preliminary acts are carried out, the economic operator must be regarded as a taxable person with a right to deduct VAT.
In that context, it is the acquisition of certain goods or services by a taxable person acting in that capacity which determines the application of the VAT mechanism and, implicitly, the exercise of the right to deduct. Accordingly, in the present case, even though we are talking about an acquisition in the early stages of a real estate project, the Court found that the purchase of the land, the demolition of the existing buildings on that land and the construction of other residential buildings on that land also constitute a series of interlinked operations, and that it is therefore not necessary to exclude the ‘preliminary’ acts from that causal chain. Having regard to the facts, the Court held that there were sufficient objective elements to establish that the economic operator intended to use the acquired land for the future construction of residential buildings.
The importance of this case has also been recognized in the national legal system by Article 67 of the Methodological Norms for the application of the Tax Code, referring to Article 297 of the Tax Code, which regulates in general the right to deduct VAT. Therefore, the Methodological Norms practically transpose the considerations of the European Court of Justice, concerning the acquisition of land and the right to deduct VAT on this acquisition, in paragraph 18 of the same Article. In settling the tax appeal of the economic operator aforementioned, the assessing body took into account the application of these provisions of the Methodological Rules in order to substantiate its decision.
Even on other occasions, the European Court of Justice has ruled in favor of recognizing the right of deduction at the time of the first investments by taxable persons in cases such as Belgische Staat v. Gent Coal Terminal NV, C-37/95, Intercommunale voor zeewaterrontzilting (INZO), C-110/94. In those cases the Court concluded that the right of deduction may be exercised in respect of the performance of acts preparatory to the taxable purpose even where, owing to circumstances beyond the control of the taxable person, the taxable purpose has no longer been achieved and even where no income has been obtained, it being sufficient that at the time of the acquisition the income was assigned to the taxable purpose envisaged by the trader. These conclusions were also reiterated in a Romanian case, namely ITH Comercial Timișoara SLR, C-734/19, where the Court stated that in order to exercise the right of deduction it is sufficient that the taxable person actually intended to use the goods or services for the purpose of carrying out the economic activities for which he exercised his right of deduction, even if those economic activities were not subsequently realized.
The European Court’s considerations in Rompelman, C-268/83 are also relevant. The subject-matter of this case was the acquisition of a claim to the future co-ownership of two plots of land in a building under construction, which were subsequently to be let to traders. The Court of Justice noted, at para. 14 of its judgment, that the key question in the case was whether the acquisition of rights in property to be constructed constituted an “economic activity” within the meaning of European VAT law. In this case, the Court held that the exercise of the right of deduction was justified, recognizing that it was not necessary to differentiate between the legal forms that preparatory acts of taxable persons may take, in particular between the moment of acquisition of the right of ownership of future property and the actual acquisition of the right of ownership of the property. Among other things, the Court has held that it would be contrary to the principle of fiscal neutrality in the field of VAT to draw a distinction between investment expenditure incurred before the property is actually exploited and that incurred after the actual exploitation of the property has begun. Accordingly, any person who carries out transactions relating to acts preparatory to his economic activity for taxable purposes which are closely connected with and necessary for the future exploitation of immovable property must be regarded as a taxable person within the meaning of Article 9 of the VAT Directive.
V. Conclusions
What we can conclude from these rulings of the Court of Justice of the European Union is that the right to deduct VAT is not conditional on a specific point in time, as in the case of the company, on the issuance of a building permit or another administrative act of the local public authority, such as a Zonal Urban Development Plan, and it is therefore sufficient that the economic operator makes the purchase for taxable purposes, for the conduct of its economic activity.
The fact that the construction of a real estate project still at the authorization stage, which is indeed a future event, cannot constitute a factor that prevents the exercise of a right of deduction. This is all the more so since, in the case of the economic operator initially presented, there were sufficient objective elements to establish that the purchases were made for taxable purposes, namely for the concretization and realization of the real estate project, still in the incipient phase. One such objective element was the imposition of tasks by the local public authority to prepare the traffic area in the immediate vicinity of the real estate project in order to obtain the building permit for the execution of the project.
In the light of the interpretative case law of the CJEU, not only is the right of deduction recognized from the moment of acquisition, without being temporally conditioned to a specific moment in time, but it has been and continues to be recognized for a series of acts prior to the realization of the purposes of the economic activity of the taxable person. This is a natural and logical conclusion, transposing the conditions governing the exercise of the right to deduct VAT, namely that the acquisition must be made with the intention of being used for taxable purposes.
In conclusion, we consider that the decision of the ruling authority of the Minister of Finance is the consequence of the application of Community VAT principles in relation to ongoing real estate investments. Even if it is at an early stage, this should not lead to a refusal to exercise the right of deduction. Otherwise, the principle of fiscal neutrality with regard to that indirect tax could not be ensured, particularly in view of the significant costs which economic operators incur in the preliminary stages of building construction.
This article has been prepared for the blog of the law firm Costaș, Negru & Asociații by lwy. Diana Hoha Pop from the Arad Bar Association.
Costaș, Negru & Asociații is a law firm with offices in Cluj-Napoca, Bucharest and Arad, which provides assistance, legal representation and advice in several practice areas through a team of 17 lawyers and consultants. Details of the legal services and the composition of the team can be found at https://www.costas-negru.ro .
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